Charitable giving can help you minimize taxes while also supporting causes are meaningful to you.

Christmas is a season of giving—giving gifts to friends and loved ones; giving notes of thanks and tips to the trash collectors, mail delivery persons, landscapers, hair stylists, and all those who make our lives a bit easier; and giving our time or money to various charities asking for help this time of year. The last few months of the year make up what is commonly called the “Giving Season” for the non-profit community. As the holidays near, people feel encouraged to give more generously than during the rest of the year.

According to Steve MacLauglin, a director of product management for Blackbaud Index, approximately 34% of all charitable giving is done in the last three months of the year. Of those donations, nearly 18% are given in December alone.

In truth, we should feel the need to donate in some way to charities throughout the year. Non-profits operate all 12 months of the year and need assistance continually. For many, charitable giving is a way of life. Whether it’s to support an organization that’s touched your life in a meaningful way, a school or university that put you on the road to success, or simply a cause that you feel passionate about, charitable giving not only offers emotional benefits, but practical ones as well.

Giving Now…And After You’re Gone

For many donors, the big question is how much to give throughout your lifetime and what to leave as charitable gifts in a will or trust. For those who are not concerned about the use of assets during their lifetime—for care, or enjoyment—a charitable gift may be a regular occurrence. Some may choose to pass on assets after death, in addition to, or sometimes in place of, passing on assets to family members.

The options for charitable giving within an estate plan are varied. Before you choose a way to give, it’s important to understand the tax implications of your decisions. Giving as much as you want to charity during your lifetime and after you’re gone may help to reduce federal estate and gift taxes significantly.

Gifts made to charities, specifically, are exempt from gift tax.

Giving Throughout Your Lifetime

Generally speaking, lifetime gifts to charities can result in an income tax deduction for you, according to Fidelity Investments. But before you make a large gift, be sure to seek tax advice from an experienced attorney. You’re eligible for itemized deductions for charitable contributions up to a certain percentage of your adjusted gross income for cash contributions. Another limit applies for contributions of appreciated securities or property in any one year. You may be able to carry forward amounts that exceed the limit and deduct them over the next five years.

Highly-appreciated securities may be good candidates to give to charity during your lifetime; in addition to the income tax deduction, you bypass the capital gains tax that would be owed if you cashed them in yourself.

Know Your Options

Whether you choose to give during your lifetime or in your will, donor-advised funds are charitable giving programs generally run by public charities or financial institutions. They allow you to give on a basis intended to maximize your income tax situation and help meet the needs of the causes meaningful to you.

If you have the means and desire to play an active role in philanthropy, you might also consider establishing a private foundation. Foundation managers retain control over the investment of their foundation assets, as well as which charities will receive grants from the foundation. In addition to charities, foundation grants can be used to support individuals for hardship reasons and even scholarship programs. Along with this flexibility, however, is a significant amount of administration.

Creating Trusts

A charity can be the beneficiary of a relatively simple revocable trust or irrevocable trust. Other giving strategies using charitable trusts can provide benefits to charity as well as to your family or yourself.

A charitable lead trust lets you provide a payout to a charitable cause during your lifetime (or a term of years) and preserve assets for other beneficiaries, such as children or grandchildren. The value of the remainder gifted to your descendants will be a taxable gift if the trust is funded during your lifetime, or subject to estate tax, if the trust is funded at your death.

If you have substantially appreciated assets (real estate or stocks), you can reduce current capital gains tax on the assets by contributing the assets to a charitable remainder trust. You may also give a portion of the current value of your assets to charity, and generate a payout from the trust to yourself or someone else during your lifetime, or for a specific term.

Ensure your beneficiaries are up to date on other assets that have provisions for naming them, including investment and bank accounts with transfer on death designations. This is especially important for beneficiaries outside your immediate family, as assets don’t usually go to such beneficiaries by default or outside of the probate process if they’re not named properly.
Retirement Accounts

Retirement assets may be good candidates for charitable bequests because they can be among the highest taxed assets in any estate. Fidelity Investments reveals that leaving your retirement assets to a charity has two distinct advantages:

Increasing the impact of your bequest—the charity would not have to pay income taxes on your donation when it receives assets from your retirement account.

Decrease the estate tax burden for your family—your assets would pass directly to the charitable organization, so your estate would be eligible for a federal estate tax charitable deduction on the account’s value.

Of course, make sure your beneficiary designations are up to date. If you have missing or incorrect designations, your assets may not be distributed as you intend or your charitable beneficiaries may have to wait to take ownership and incur costs due to probate.

The rules for 401(k)s and other qualified retirement plans are similar to those for IRAs. If you’re married and want to designate beneficiaries other than your spouse, you may need written consent from your spouse. Otherwise, such plans follow roughly the same guidelines for what is taxable, but other features will vary from plan to plan. Be sure to contact the plan’s administrator for specific rules governing yours.

Let Oliver & Cheek, PLLC guide you in planning for charitable donations now and in the future. For more information, call (252) 633-1930 or visit www.olivercheek.com.

With the holidays quickly approaching, many businesses are busy hiring seasonal employees to keep up with the holiday rush. As with hiring any employee, well-planned hiring practices can help ensure seasonal employees are well-suited for the job.

Have you noticed the increased traffic in downtown New Bern lately? Having a harder time finding a parking spot? It’s with good reason: Thanksgiving is just around the corner and Christmas is speeding toward us at a fierce pace.

This is also the time of year when retailers, restaurants, hotels, and more hire part-time workers for the bump in consumer activity the holidays bring. These employees can simply be individuals seeking a job to supplement their current income or someone hoping to turn a temporary position into a full-time job.

Unfortunately, seasonal employment can often raise complex legal issues. Most often, these relate to things like scheduling and severance obligations. While a part-time job over the holidays is often seen as “casual,” the reality is that a legal relationship is being created. Seasonal employees are still employees—entitled to the protections afforded by employment standards legislation, health, and safety legislation and common law. It’s important that both employers and employees understand their rights and obligations.

Seasonal Employees: What to Consider

Melissa Dials, an attorney with a management side-labor and employment law firm, recently offered Crain’s Cleveland Business a few actions you can take to avoid the most common legal pitfalls when hiring seasonal workers:

What forms are needed?

Seasonal workers are just like other employees regarding new hire forms and procedures. Each employee must complete a W-4 form designating amounts to be withheld for federal income taxes, and you must verify work eligibility using Form I-9. And don’t forget state income tax withholding and other forms.

Most seasonal workers don’t receive benefits, but it’s a good idea to provide these employees with a copy of your company’s employee handbook or policies and procedures manual.

Should you classify the worker as an “independent contractor?”

Businesses often misclassify employees as independent contractors and, in the process, open themselves up to potential liability. Employers should be sure to avoid designating a seasonal worker as an independent contractor without first determining that the circumstances legally justify such a classification.

You’ll need to clarify expectations regarding the duration of employment.

Although seasonal employees are generally aware they’ve been hired on a temporary basis, employers should be sure to specify the limited duration of employment both at the onset and in writing. In addition, employers should require any seasonal employees to acknowledge, in writing, they understand they are being hired for a limited duration and are “at-will” employees—meaning the employer has a legal right to terminate the employee, with or without cause, at any time.

What rules apply?

Most employment laws, except the Family and Medical Leave Act (FMLA), apply to seasonal employees. Unless employment continues beyond the holiday season, seasonal employees are ineligible for FMLA leave because they will not work the required 1,250 hours in a 12-month period. However, other employment laws such as those prohibiting employment discrimination, harassment and retaliation apply with equal force to seasonal workers. Employers should take steps to prevent and address such allegations by seasonal employees in the same manner as they would for regular employees.

Watch the clock.

The federal Fair Labor Standards Act (FLSA) requires employers to pay any non-exempt employees one-and-one-half times their regular rate of pay for any hours worked in excess of 40 in a given workweek. However, federal law does exempt certain individuals from overtime requirements. Under the FLSA, for example, employees of certain seasonal amusement or recreational establishments, organized camps, and religious or non-profit educational institutions are generally exempt from overtime pay. It’s important that employers review their seasonal employees’ status under federal and state law to determine whether they are exempt from paying overtime to employees.

Develop telecommuting policies and procedures.

Many retailers are hiring remote workers for customer service positions to improve productivity and efficiency. Telecommuting, however, raises unique legal issues that employers need to address with established policies and procedures before they become a liability. For example, the Occupational Safety and Health Act (OSHA) requires employers provide a safe workplace to all employees—even those working from home. In addition, workers’ compensation laws still apply to telecommuters. To address these issues, employers can require telecommuters to have a designated workspace that has been inspected and approved by the company to comply with workplace safety obligations.

Conduct training for managers.

Before the holiday rush, managers should understand that most rules apply with equal force to seasonal workers. In addition, they should be trained on how to address reports of harassment and discrimination for all employees, and how to respond to requests for accommodations. For example, employees may request time off during the holiday season for religious reasons. Managers should be trained to engage in a discussion with employees to determine what the religious requirements are and whether they can be accommodated.

Review benefits policies.

Federal law does not require employers to provide the same benefits to seasonal workers as they do regular, full-time employees. However, if a seasonal employee works more than 30 hours per week for a period longer than 120 days, the employer may be required to offer health insurance under the Affordable Care Act (ACA). Employers should review their benefits policies and health plan documents to determine if seasonal workers are eligible, as these documents can control when they provide benefits more generous than what the law requires. Failure to provide required benefits can lead to expensive consequences.

Following these guidelines may seem unnecessary and time consuming when you’re under pressure to quickly hire help during the hectic holiday season, but failure to follow such simple steps may lead to unexpected expenses and headaches you definitely don’t want to encounter.

Making hiring decisions for your small business can be a daunting task. It’s important that you’re familiar with North Carolina law, so let Oliver & Cheek, PLLC guide and assist you. For more information, call (252) 633-1930 or visit www.olivercheek.com.

(Sources: U.S. Small Business Administration; North Carolina Department of Labor; Crain’s Cleveland Business; The Globe and Mail, Inc.; Business News Daily; The Balance; and Retail Minded.)

Independent Contractors or Employees? Discover What’s Best for Your Small Business

When your small business isn’t so small anymore it may be time to hire help. Money is still tight so you want to be sure you’re getting the most “bang for your buck” when considering new hires. But what route do you take? Do you take the plunge and hire employees or rely on contractors to fill your needs?

The Society for Human Resource Management (SHRM) recommends that you consider a variety of factors—and none of them in isolation—when deciding whether to meet a staffing need by means of independent contractors (ICs) or employees. The group also suggests that you work closely with a business attorney to weigh the requirements of the job, in combination with other factors, to determine whether an IC will both meet your staffing needs and withstand legal scrutiny, thus avoiding future problems.

Let’s take a look at the major differences between ICs and employees to help you make the decision that’s right for your situation.

Benefits of Using Independent Contractors

Forbes Magazine relates that several advantages are seen when using ICs rather than employees:

Cost

When you hire an employee, you are required to pay several expenses you don’t have to pay with ICs, including the cost of employer-provided benefits, office space, and equipment. You’ll also have to make required payments and contributions on behalf of your employees, including your share his or her Social Security and Medicare taxes (which comes to 7.65 percent of his or her total compensation); state unemployment compensation insurance; and workers’ compensation insurance. These payments can easily increase your payroll costs by 20 to 30 percent or more.

Flexibility

Working with ICs will allow greater leeway in hiring and firing of workers, which can be especially advantageous if you’ll be experiencing fluctuating workloads. You can hire an IC for a specific task or project knowing that he or she will be gone when the job is finished. The trauma, expense, and potential legal trouble that can accompany firings and layoffs is completely avoided.

Efficiency

Because most ICs bring specialized expertise to the job they can usually be productive immediately—eliminating the time and cost of training. With ICs, you can expand and contract your workforce as needed without taking on unnecessary expenses.

Legal Matters

Employees are afforded a wide array of rights under state and federal law; they can potentially bring forth legal claims for any perceived violation of those rights. Because ICs are considered independent businesspeople, they are not protected by many of these laws. Employees can also sue for wrongful termination in circumstances that vary from state to state. ICs cannot bring this type of lawsuit.

Benefits of Using Independent Contractors

After reading about the possible benefits of hiring ICs, you may be thinking that you’ll never hire an employee again. But there are also important benefits you’ll see when hiring employees, as explained by Forbes:

Control

If you want to exercise ultimate control over what goes on in your company or business, you should hire employees. Employees can be closely supervised and micromanaged to your heart’s content while ICs enjoy a certain autonomy to decide how best to do the job. If you interfere too much in an IC’s work, you risk making him or her look like an employee—in other words, someone for whom you should be paying payroll taxes, workers’ compensation insurance premiums, and more.

Stability

Many employers use ICs only as needed for relatively short-term projects. This means that workers will be constantly coming and going, which can be inconvenient and disruptive. And the quality of work you get from various ICs may be uneven. If you want the same workers available day after day hire employees.

Termination Options

Your right to fire an IC depends on your written agreement. You don’t have an unrestricted right to fire an IC, as you might with your employees. Your right to terminate an IC’s services is limited by the terms of your written IC agreement. If you fire an IC in violation of the agreement, you could be liable for damages.

Legal Liability

You may be liable for injuries an IC suffers on the job. In contrast, employees injured on the job are generally covered by workers’ compensation insurance. In exchange for the benefits they receive for their injuries, these employees give up the right to sue their employer for damages. ICs are not covered by workers’ compensation, which means that they can sue for damages if they are injured on the job because of your carelessness.

Content Ownership

If you hire an IC to create a work that can be copyrighted—such as an article, book, or photograph—you may not be considered the owner of the work unless you have a written agreement transferring copyright ownership from the IC to you. If an employee creates such a work, you automatically own copyright of the work in most circumstances.

Avoiding Tax Complications

State and federal agencies, particularly the IRS, want to see as many workers as possible classified as employees, not ICs. The reason is financial: The more workers classified as employees, the more tax and insurance money flows into government coffers and the harder it is for workers to underreport or hide their income from the agency.

Your business could face an audit if it appears you’ve misclassified employees as ICs. At the state level, you could attract the attention of your state’s unemployment compensation or workers’ compensation agency if a someone you classified as an IC applies for benefits. You could also face an audit from your state’s tax agency.

It all comes down to this: Whether you hire a contractor or an employee will depend greatly on what kind of position you’re trying to fill and how you see the position developing. If it’s a short-term position that doesn’t involve the kind of expertise you need to have on tap all the time, hiring a freelancer can be a great alternative for your small business.

Making complex hiring decisions for your small business can be a daunting task. Trying to choose between hiring employees or contractors? Let Oliver & Cheek, PLLC guide you and assist in the mapping of future expansion. For more information, call (252) 633-1930 or visit www.olivercheek.com.

The type of business you form will determine how much profit you earn, how much you pay in taxes, how operations decisions are made, how much control you have…and your legal needs and responsibilities.

Let’s review: When starting a new business, you must first decide which legal form of ownership will be best for you and your business. Do you want to be your own boss and operate as a sole proprietorship? Or would you rather share the responsibilities of ownership and create a corporation or partnership? The answer to questions such as these are crucial to ask yourself before setting up your business model.

As we discussed in Part I of this article, no one business model will give you everything on your wish list. Each form of ownership has advantages and disadvantages so you’ll need to determine which offers the features most important to you. You should always consult an attorney before selecting a business model, as each structure consists of unique legal and tax consequences.

In Part I we addressed sole proprietorships, LLCs, and corporations. This time, we’ll look at three additional business structures, as described by the U.S. Small Business Administration, along with formation steps, tax obligations, and the pros and cons of each. Partnership

A partnership is a single business where two or more people share ownership. Each partner contributes to all aspects of the business, including money, property, labor, or skill. In return, each partner shares in the profits and losses of the business.

Because partnerships entail more than one person in the decision-making process, it’s important to discuss a wide variety of issues up front and develop a legal partnership agreement. This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners), and how to dissolve the partnership. Although partnership agreements are not legally required, they are strongly recommended and it is considered extremely risky to operate without one.

Types of Partnerships

Three general types of partnership arrangements exist:

General Partnerships assume that profits, liability, and management duties are divided equally among partners. If you opt for an unequal distribution, the percentages assigned to each partner must be documented in the partnership agreement.

Limited Partnerships (also known as a partnership with limited liability) are more complex than general partnerships and allow partners to have limited liability as well as limited input with management decisions. These limits depend on the extent of each partner’s investment percentage. Limited partnerships are attractive to investors of short-term projects.

Joint Ventures act as a general partnership, but for only a limited period of time or for a single project. Partners in a joint venture can be recognized as an ongoing partnership if they continue the venture, but they must file as such.

Forming a Partnership

To form a partnership, you must register your business with your state, a process generally done through your Secretary of State’s office. You’ll also need to establish your business name. For partnerships, your legal name is the name given in your partnership agreement or the last names of the partners. If you choose to operate under a name different than the officially registered name, you’ll need a DBA.

Most businesses will need to register with the IRS, register with state and local revenue agencies, and obtain a tax ID number or permit. A partnership must file an “annual information return” to report the income, deductions, gains, and losses from the business’s operations, but the business itself does not pay income tax. Instead, the business “passes through” any profits or losses to its partners. Partners include their respective share of the partnership’s income or loss on their personal tax returns.

The IRS asks that you use this chart to determine which forms you are required to file.

Advantages:

Easy and inexpensive: Partnerships are generally an inexpensive and easily formed business structure. Most of the time spent starting a partnership focuses on developing the partnership agreement.

Shared financial commitment: In a partnership, each partner is equally invested in the success of the business. Partnerships have the advantage of pooling resources to obtain capital. This could be beneficial in terms of securing credit, or by simply doubling your seed money.

Complementary skills: A good partnership should reap the benefits of being able to utilize the strengths, resources, and expertise of each partner.

Partnership incentives for employees: Partnerships have an employment advantage over other entities if they offer employees the opportunity to become a partner. Partnership incentives often attract highly-motivated and qualified employees.

Disadvantages:

Joint and individual liability: Like sole proprietorships, partnerships retain full, shared liability among the owners. Partners are not only liable for their own actions, but also for the business debts and decisions made by other partners. In addition, the personal assets of all partners can be used to satisfy the partnership’s debt.

Disagreements among partners: With multiple partners, there are bound to be disagreements Partners should consult each other on all decisions, make compromises, and resolve disputes as amicably as possible.

Shared profits: Because partnerships are jointly owned, each partner must share the successes and profits of their business with the other partners. An unequal contribution of time, effort, or resources can cause discord among partners.

Cooperative

A cooperative is a business or organization owned by, and operated for the benefit of, those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.

Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the number of shares they hold does not affect the weight of their vote. Cooperatives are common in the healthcare, retail, agriculture, art, and restaurant industries.

Forming a Cooperative

To start up, a group of potential members must agree on a common need and a strategy on how to meet that need. An organizing committee then conducts exploratory meetings, surveys, and cost and feasibility analyses before every member agrees with the business plan. Not all cooperatives are incorporated, though many choose to do so. If you decide to incorporate your cooperative, you must complete the following steps:

File articles of incorporation: The articles of incorporation legitimize your cooperative and include information like the name of the cooperative, business location, purpose, duration of existence, and names of the incorporators, and capital structure. Once the charter members file with your state business entity registration office and the articles are approved, you should create bylaws for your cooperative.

Create bylaws: While bylaws are not required by law, they do need to comply with state law and are essential to the success of your cooperative. Bylaws list membership requirements, duties, responsibilities, and other operational procedures that allow your cooperative to run smoothly. According to most state laws, the majority of your members must adopt articles of incorporation and bylaws. Consult your attorney to verify your bylaws comply with state laws.

Create a membership application: To recruit members and legally verify that they are part of the cooperative, you must create and issue a membership application. Membership applications include names, signatures from the board of directors, and member rights and benefits.

Conduct a charter member meeting and elect directors: During this meeting, charter members discuss and amend the proposed bylaws. By the end of the meeting, all charter members should vote to adopt the bylaws. If the board of directors are not named in the articles of incorporation, they must be designated during the charter meeting.

Obtain licenses and permits: You must obtain relevant business licenses and permits. Regulations vary by industry, state, and locality. Refer to our Business License and Permit guide to find a list of federal, state, and local permits, licenses and registrations you’ll need to run a business.

Be sure to consult with an attorney to ensure your cooperative is following the laws established in North Carolina.

Cooperative Taxes

Most businesses must register with the IRS, state, and local revenue agencies, and obtain a tax ID number or permit. A cooperative operates as a corporation and receives a “pass-through” designation from the IRS. More specifically, cooperatives do not pay federal income taxes as a business entity.

Instead, the cooperative’s members pay federal taxes when they file their personal income tax. Members pay federal and state income tax on the margins earned by the cooperative, though the amount of taxation varies slightly by state. Cooperatives must follow the rules and regulations of the IRS’s Subchapter T Cooperatives tax code to receive this type of tax treatment.

Some cooperatives, like credit unions and rural utility cooperatives, are exempt from federal and state taxes due to the nature of their operations.

Advantages:

Less taxation: Like an LLC, cooperatives that are incorporated normally are not taxed on surplus earnings (or patronage dividends) refunded to members. Therefore, members of a cooperative are only taxed once on their income from the cooperative and not on both the individual and the cooperative level.

Funding Opportunities: Depending on the type of cooperative you own or participate in; a variety of government-sponsored grant programs are available to help you start. For example, the USDA Rural Development program offers grants to those establishing and operating new and existing rural development cooperatives.

Reduce costs and improve products and services: By leveraging their size, cooperatives can more easily obtain discounts on supplies and other materials and services. Suppliers are more likely to give better products and services because they are working with a customer of more substantial size. Consequently, the members of the cooperative can focus on improving products and services.

Perpetual existence: A cooperative structure brings less disruption and more continuity to the business. Unlike other business structures, members in a cooperative can routinely join or leave the business without causing dissolution.

Democratic organization: The democratic structure of a cooperative ensures that it serves its members’ needs. The amount of a member’s monetary investment in the cooperative does not affect the weight of each vote, so no member-owner can dominate the decision-making process. The “one member-one vote” philosophy particularly appeals to smaller investors because they have as much say in the organization as does a larger investor.

Disadvantages:

Obtaining capital through investors: Cooperatives may suffer from slower cash flow since a member’s incentive to contribute depends on how much they use the cooperative’s services and products. While the “one member-one vote” philosophy is appealing to small investors, larger investors may choose to invest their money elsewhere because a larger share investment in the cooperative does not translate to greater decision-making power.

Lack of membership and participation: If members do not fully participate and perform their duties, whether it be voting or carrying out daily operations, then the business cannot operate at full capacity. If a lack of participation becomes an ongoing issue for a cooperative, it could risk losing members.

S Corporation

An S corporation (also referred to as an S corp.) is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

An S corp. is a corporation with the Subchapter S designation from the IRS. What makes the S corp. different from a traditional corporation (or C corp.) is that profits and losses can pass through to your personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. There is an important caveat, however: Any shareholder who works for the company must pay him or herself “reasonable compensation.” Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages.”

Forming an S Corporation

To file as an S corporation, you must first file as a corporation. After you are considered a corporation, all shareholders must sign and file Form 2553 to elect your corporation to become an S corporation.

Once your business is registered, you must obtain business licenses and permits. Regulations vary by industry, state, and locality. Refer to the Business License and Permit guide to learn more.

Combining the Benefits of an LLC with an S Corp.

There’s always the possibility of requesting S corp. status for your LLC. Your attorney can advise you on the pros and cons. You’ll have to make a special election with the IRS to have the LLC taxed as an S corp. using Form 2553. And you must file it before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.

The LLC remains a limited liability company from a legal standpoint, but for tax purposes it’s treated as an S corp. Be sure to contact your state’s income tax agency where you will file the election form to learn about tax requirements.

Taxes

All states do not tax S corps equally. Most recognize them similarly to the federal government and tax the shareholders accordingly. Your corporation must file the Form 2553 to elect “S” status within two months and 15 days after the beginning of the tax year or any time before the tax year for the status to be in effect.

The IRS asks that you use this chart to determine which forms you are required to file.

Advantages:

Tax savings: One of the best features of the S corp. is the tax savings for you and your business. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S corp. shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a “distribution,” which is taxed at a lower rate, if at all.

Business expense tax credits: Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, benefits like health and life insurance are deemed taxable income.

Independent life: An S corp. designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S corp. can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders.

Shareholder compensation requirements: A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations, and may reclassify your distributions as wages. You could pay a higher employment tax because of an audit with these results.

Structuring the way in which your business will be run and organized can be a daunting task. Trying to choose between registering as a sole proprietorship, general partnership, corporation, or limited liability company? Let Oliver & Cheek, PLLC guide you in these types of decisions, the creation of job titles and duties, and the mapping of future expansion. For more information, call (252) 633-1930 or visit www.olivercheek.com.

The type of business you form will determine how much profit you earn, how much you pay in taxes, how operations decisions are made, how much control you have…and your legal needs and responsibilities.

When starting a new business, you must first decide which legal form of ownership will be best for you and your business. Do you want to be your own boss and operate as a sole proprietorship? Or would you rather share the responsibilities of ownership and create a corporation or partnership? The answer to questions such as these are crucial to ask yourself before setting up your business model.

Here are a few additional questions you should be asking yourself as well:

Do you have the required skills to run a business?

How much control do you want over your business?

Are you willing to share any of the responsibilities?

Are you open to sharing profits?

How do you plan to finance the company?

Do you want to avoid certain taxes?

How important to you is it that your business survives?

If you have partners, do you think you’ll be able to get along with them?

How much personal liability are you willing to accept? Will you share liability?

No one business model will give you everything on your wish list. Each form of ownership has advantages and disadvantages so you’ll need to decide which offers the features most important to you. Before selecting a business structure, it’s best to consult an attorney as each structure carries with it unique legal and tax consequences.

Let’s take a look at the different forms of business models, as described by the U.S. Small Business Administration, along with formation steps, tax obligations, and the pros and cons of each.

Sole Proprietorship

The most common—and the simplest—type of business ownership is the sole proprietorship. It is an unincorporated business owned and run by one individual with no distinction between the business and the owner. The owner is entitled to all profits and is responsible for all business debts, losses, and liabilities.

If the business is conducted under a name other than the surname of the owner, an assumed name certificate (a DBA or “doing business as”) should be filed with the state or county. A sole proprietorship may not be owned by more than one person and provides no protection against liability to the owner.

Sole proprietorship income is reported on Schedule C of the owners Form 1040. Profits are treated as income of the owner and losses are deductible to the owner.

Common types of sole proprietors are writers, independent contractors, freelance photographers, salespeople working with a commission-only structure, independent contractors, or those working on a contract basis.

Forming a Sole Proprietorship

No formal action is required to form a sole proprietorship. If you are the only owner, this status automatically comes from your business activities and no formal action is required. In fact, you may already own one without knowing it. If you’re a freelance graphic designer, for example, you’re a sole proprietor. But like all businesses, you still need to obtain the necessary licenses and permits.

Sole Proprietor Taxes

Because you and your business are one and the same, the business itself is not taxed separately—the sole proprietorship income is your income. The IRS asks that you use this chart to determine which forms you are required to file.

Advantages:

Formation is easy and inexpensive: A sole proprietorship is the simplest and least expensive business structure to establish.

Complete control is yours: Because you are the sole owner of the business you have complete control over all decisions.

The unlimited personal liability: Because there is no legal separation between you and your business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred because of employee actions.

It can be hard to raise money: Sole proprietors often face challenges when trying to raise money. Because you can’t sell stock in the business, investors won’t often invest. Banks are also hesitant to lend to a sole proprietorship because of a perceived lack of credibility when it comes to repayment if the business fails.

There’s a heavy burden: The flipside of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.

Limited Liability Company (LLC)

An LLC is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. The “owners” of an LLC are referred to as “members.” Depending on the state, members can consist of a single individual (one owner), two or more individuals, corporations, or other LLCs.

Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. Members report profits and losses on their personal federal tax returns just like the owners of a partnership would.

Forming an LLC

While each state has slight variations to forming an LLC, they all adhere to a few general principles:

Choose a business name: There are thee rules your LLC name should follow: 1) it must be different from an existing LLC in your state, 2) North Carolina law requires that an LLC name contain the words “limited liability company” or the abbreviation “L.L.C.” or “LLC,” or the combination “ltd. liability co.,” “limited liability co.,” or “ltd. liability company,” and 3) it must not include words restricted by your state (such as “bank” and “insurance”). Your business name is automatically registered with your state when you register your business.

File articles of organization: The “articles of organization” is a simple document that legitimizes your LLC and includes information like your business name, address, and the names of its members. The filing fee in North Carolina is $125. The Secretary of State’s website has a simple, fill-in-the-blank form for the articles of organization. Instructions are included. For general information, see the Articles of Organization page.

Create an operating agreement: North Carolina does not require an operating agreement to form an LLC, but executing one is highly advisable. There’s no set criteria for the content of an operating agreement, but it typically includes topics such as how meetings are conducted, how the company will be managed, what capital contributions are required from each member, and how profits and losses will be allocated. The operating agreement does not need to be filed with the state.

Obtain licenses and permits: You can view North Carolina’s requirements at the Secretary of State’s website.

Other requirements: North Carolina LLCs must file an annual report with the Secretary of State every year after the date of formation. The filing fee is $200. The form can be found online at the Online Annual Report Editor page.

LLC Tax Obligations

In the eyes of the federal government, an LLC is not a separate tax entity, so the business itself is not taxed. Instead, all federal income taxes are passed on to the LLC’s members and are paid through their personal income tax. While the federal government does not tax income on an LLC, some states do, so check with your state’s income tax agency.

Since an LLC is not recognized as a business entity for taxation purposes, all LLCs must file as a corporation, partnership, or sole proprietorship tax return. Certain LLCs are automatically classified and taxed as a corporation by federal tax law.

Limited liability: Members are protected from personal liability for business decisions or actions of the LLC. If the LLC incurs debt or is sued, members’ personal assets are usually exempt. This is like the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means just that—members are not necessarily shielded from wrongful acts, including those of their employees.

Less Recordkeeping: An LLC’s operational ease is one of its greatest advantages. Compared to an S Corporation, there’s less registration paperwork and start-up costs are lower.

Shared profits: There are fewer restrictions on profit sharing within an LLC, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat equity. Consequently, it’s up to the members themselves to decide who has earned what percentage of the profits or losses.

Disadvantages:

Limited life: In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business. The remaining members can decide if they want to start a new LLC or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC if a member decides to leave the business.

Self-employment taxes: Members of an LLC are considered self-employed and must pay the self-employment tax contributions toward Medicare and Social Security. The entire net income of the LLC is subject to this tax.

Corporation

A corporation (sometimes referred to as a C corporation) is an independent legal entity owned by shareholders—the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs.

Corporations are more complex than other business structures because they tend to have costly administrative fees and complex tax and legal requirements. Because of these issues, corporations are generally suggested for larger, more established companies with multiple employees.

For businesses in that position, corporations offer the ability to sell ownership shares in the business through stock offerings. “Going public” through an initial public offering (IPO) is a major selling point in attracting investment capital and high-quality employees.

Forming a Corporation

A corporation is formed under the laws of the state in which it is registered. To form a corporation, you’ll need to establish your business name and register your legal name with your state government. If you choose to operate under a name different than the officially registered name, a DBA is needed. State laws vary, but generally corporations must include a corporate designation (Corporation, Incorporated, or Limited) at the end of the business name.

To register your business as a corporation, you typically need to file articles of incorporation with your state’s Secretary of State office. Some states require corporations to establish directors and issue stock certificates to initial shareholders in the registration process. Contact your state business entity registration office to find out about specific filing requirements in the state where you form your business.

Once your business is registered, you must obtain business licenses and permits. Regulations vary by industry, state and locality. Refer to our Business License and Permit guide to find a listing of federal, state and local permits, licenses and registrations you’ll need to run a business.

Corporations are required to pay federal, state, and in some cases, local taxes. Most businesses must register with the IRS and state and local revenue agencies, and receive a tax ID number or permit. Unlike sole proprietors and partnerships, corporations pay income tax on their profits. In some cases, corporations are taxed twice: First, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.

The IRS asks that you use this chart to determine which forms you are required to file.

Advantages:

Limited liability:When it comes to taking responsibility for business debts and actions of a corporation, shareholders’ personal assets are protected. Shareholders can generally only be held accountable for their investment in stock of the company.

Ability to generate capital: Corporations have an advantage when it comes to raising capital for their business: The ability to raise funds through the sale of stock.

Corporate tax treatment: Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate.

Attractive to potential employees: Corporations are generally able to attract and hire high-quality and motivated employees because they offer competitive benefits and the potential for partial ownership through stock options.

Disadvantages:

Time and money: Corporations are costly and time-consuming ventures to start and operate. Incorporating requires start-up, operating, and tax costs that most other structures do not require.

Double taxing: In some cases, corporations are taxed twice: First, when the company makes a profit, and again when dividends are paid to shareholders.

Additional paperwork:Because corporations are highly regulated by federal, state, and, in some cases, local agencies, increased paperwork and recordkeeping burdens are associated with this entity.

So far, we’ve only examined three of the most common types of business models. In Part II of this article, three additional models—partnerships, cooperatives, and S Corporations—will be discussed. Stay tuned!

Structuring the way in which your business will be run and organized can be a daunting task. Trying to choose between registering as a sole proprietorship, general partnership, corporation, or limited liability company? Let Oliver & Cheek, PLLC guide you in these types of decisions, the creation of job titles and duties, and the mapping of future expansion. For more information, call (252) 633-1930 or visit www.olivercheek.com.